When you’re in business it’s like the floodgates open and out pours every opportunity to buy some kind of insurance you had never even dreamed of. As with all things insurance from the time Gerber is hitting up your parents until your children are trying to keep your Medicare supplements straight, we are inundated with insurance offers that come from every direction. We have no doubt, although we haven’t found it yet, that there is a type of insurance out there that insures all of your other insurance policies against non-payment of benefits.
At Risk Life we only sell life and disability income insurance, two products that have stood the test of time as being worthwhile. We’ve chosen to stay focused and strong in what we do so when the subject of partnerships and buy/sell agreements comes up we aren’t scrambling to figure out what to do. Life insurance always has been and will continue to be the most cost effective way to protect a business from the untimely death of a partner or principle in a business.
We have a business. We know how, especially in the beginning, your attention is on profit and survival and the thought process isn’t likely to just wander to the other end of the spectrum, The End. But somewhere in there it’s a prudent discussion to have. We hear it all the time, “Just what I need, one more expense”, but the risk of not having life insurance funding a buy/sell agreement is that if a partner or principle dies, by law you, as the surviving partner owe the family of the deceased his or her portion of the business. In most states if you are not in a position to pay the family the fair market value of that portion, they can take over the deceased person’s position in the company or force you to liquidate the company or borrow the money to buy them out.
So let’s put some legs on this idea and see what it would look like. For ease we will make this a business worth $1 million with two partners that each own 50%. By the way, we’ve found that women get this concept far more than a man which is directly related to guys really believing they’re immortal. Subject for another post. So one morning one of the partners discovers that the other one was mortal and died in a car accident or of a heart attack or because he had a heart attack that led to a car accident, but however it happened his partner is now dead. We haven’t seen a lot of businesses with a valuation of $1 million that have $500,000 in extra cash laying around so we can assume in almost all cases that the surviving partner won’t just run a check over to the widow(er). We’ve also seen very few $1 million businesses that could walk into the bank and explain that their partner just died and borrow $500,000 against a damaged business.
We have also found very few partnership where it would be practical for a surviving partner to integrate a member of the family of the deceased into the business. It can work, but it would be rare. Being successful partners is a hard thing to pull off. You really have to have two people on the same page all the time or two people that work well together because they comfortable with each other’s role on different pages. Just throwing in a sub and hoping it works out is the stuff that business nightmares are made of.
So, we’re pretty sure there isn’t enough cash in the drawer to pull off a buy out and we’re pretty sure our banker is going to prefer not to participate in our desperate attempt to salvage the business. It’s also likely a family member moving into your partner’s office isn’t going to work either. So, in the absence of the buy/sell agreement (funded), the only option left is to liquidate the business and split whatever comes from that. We can only guess, but liquidating a business rarely nets the true value.
But what if the two partners are women and they see the big picture. They each take out $500,000 of life insurance on the other with themselves as the beneficiary. They have a legal buy/sell agreement put in force that dictates that when a surviving partner receives that death benefit the only thing they can use it for is to purchase their partner’s half of the business from her family. It’s neat. It’s tidy. It’s fair. And it is probably the least expensive insurance you’ll own.
P.S. Even if you and your partner can’t afford to insure that entire value of the business, you can agree to fund a lower amount until the full amount can be afforded. And a good buy/sell agreement should have room for growth, but with growth comes the income to increase the valuation and funding of the buy/sell agreement. If you have any questions or just want to get an idea what it takes to fund something for your company, call or email us directly.
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